BEPS – The Australian response: OECD but with a twist…

At the conclusion of its Base Erosion and Profit Shifting (BEPS) Project, the OECD’s Final Report on Action 13 recommended multilateral action by all members (and others) in the form of Country-by-Country Reporting.

As a result, most developed nations have now adopted the recommendations for large multinationals to provide the three recommended levels of reports – Country-by-Country Report; Master File and Local File1.

In Australia, however, the response has been to both align with – and diverge from – the OECD. As a heavy capital-importing country, Australia has long had robust transfer pricing rules with successive governments alert to revenue risks and a Tax Office willing to challenge the largest of multinationals2.
So it’s perhaps not wholly surprising that whilst it has whole-heartedly embraced the concept of CbC Reporting and multilateral action in general, it has also taken significant additional unilateral steps without waiting for further OECD recommendations. In particular, similarly to the UK, Australia has introduced a new Diverted Profits Tax along with a specific Multinational Anti-Avoidance Rule – both aimed squarely at Australian subsidiaries of large Multinationals.

Does this Affect My Clients?

Before we consider the new rules, it would be good to know to whom they apply. In Australia, the bar has been set at the A$1bn mark – effectively, an approximation of the Euro 750m suggested in the OECD’s Report. Broadly, all entities in Australia that are included in the consolidated accounts of a parent entity with over A$1bn of global turnover will be deemed a “Significant Global Entity” (SGE) – regardless of the size of their Australian operations.

What if my client is an SGE?

Broadly, an SGE has:

Country-by-Country Reporting Obligations arising for any income years commencing on or after 1 January 2016, with all CbC Reports due twelve months after the end of the relevant year;

Exposure to specific late and non-lodgement penalties across a number of reporting obligations – including CbC Reporting (these can now be up to A$525,000 per entity);

Exposure to administrative penalties (e.g. on adverse ATO audit findings) of up to 100% of the tax shortfall

Obligations to file General Purpose Financial Statements with the Tax Office for all income years commencing on or after 1 July 2016 unless it has already lodged these with the Australian Securities and Investments Commission;

Exposure to the Diverted Profits Tax (DPT); and

Exposure to the Multinational Anti-Avoidance Law (MAAL).

What’s the risk / impact?

Whilst the general CbC and Penalty obligations speak for themselves to a large extent, it’s certainly important to be aware of some of the specifics of the Australian Local File requirement, the DPT and the MAAL.

Firstly, the Australian Local File requirements can be a surprise for those who have dealt with Local File requirements elsewhere. In addition to the format of the OECD Annex II recommendations (dubbed the “Short Form” Local File under Australian rules), for all but the smallest of operations, there are then additional and extensive disclosure requirements as to quantitative related party transactional data and provision of intercompany agreements (where these exist) – the “Full” Local File.

The MAAL then addresses another key issue of the OECD BEPS Project – Action 7, The Artificial Avoidance of Permanent Establishments. In brief, the concern is that whilst on a literal interpretation of Australia’s tax treaties, there is no conclusion of contracts or dependent agent in Australia, that in substance, the local Australian subsidiary is acting in all other respects as a PE of a foreign parent or associate.

In a typical scenario that the MAAL is designed to counter, a foreign parent entity would use its Australian subsidiary in an extended sales and marketing capacity but then sign the resulting contract directly between the Australian customer and the foreign associate with the latter taking the lion’s share of all entrepreneurial profit and typically rewarding the local Australian entity with a slim cost-plus mark up for marketing services.
Where the MAAL is found to apply to such circumstances, the Australian subsidiary will be taxed as if it were a PE of the foreign parent and with a normal allocation of profits attributable to that PE based on transfer pricing principles. It applies after 1 January 2016 – irrespective of when the scheme commenced.

Finally (and only briefly), the DPT seeks to attack cross border related-party arrangements lacking in commercial substance where these result in profits accruing to an overseas associate in jurisdictions with less than 80% of the corporate tax rate of Australia.

The DPT applies to income years commencing on or after 1 July 2017 but, similarly to the MAAL, to schemes or arrangements regardless of when they were entered into. Where it applies a penalty rate tax of 40% (that is, 10% greater than the current corporate tax rate) will be applied to the Australian entity on all profits deemed shifted offshore.

Notes:
1. Albeit with some differing timeframes, especially as regards Master File obligations.
2. The ATO has publically stated it is pursuing some of the world’s largest technology and mining companies.

Foreign resident capital gains tax update

Withholding

In a bid to strengthen Australia’s non-resident Capital Gains Tax (CGT) regime to assist in the collection of tax liabilities, measures were introduced on 1 July 2016 aimed at the collection of CGT from the sale of direct and indirect interests in taxable Australian property by foreign tax residents.

Because compliance with tax Laws was historically low by non-residents when it came to reporting gains, both on capital and revenue account, the measures were introduced to ensure tax was collected on any disposal of taxable Australian property. The measures apply to the buyer, so that where a foreign resident sells property in Australia the buyer is responsible for withholding and remitting to the Australian Taxation Office (ATO) a non-final withholding of 12.5% (previously 10%) of the purchase price.

The measures initially applied to sales of taxable Australian property with a market value (essentially the sale price) of A$2 million and above but now apply to sales of A$750,000 and above. The withheld amount will be creditable against the non-residents final CGT liability.

The withholding regime is limited only to taxable Australian property, being:

Lease premiums paid for the grant of a lease over real property in Australia

Mining, quarrying or prospecting rights

Interests in Australian entities whose majority assets consist of the above such property or interests

Options or rights to acquire the real property or interest therein.

With regard to indirect interests the withholding regime will apply if the purchaser knows or reasonably believes the vendor is a foreign resident, the vendor has a foreign address or requests the purchaser to make payment to an account outside of Australia. An indirect interest is a non-portfolio interest, being greater than 10%, in an entity, or holding entity of another entity, where that entity’s value is predominantly represented by taxable Australian property.

The withholding regime also provides for a number of exclusions. In the main, if the foreign resident vendor falls within one of these categories then the 12.5% withholding is not applicable:

Real property transactions with a market value under $750,000;

Transactions by entities listed on an approved stock exchange;

The foreign resident vendor is under external administration or in bankruptcy.

The withholding regime uses a clearance certificate model to provide certainty to purchasers regarding their withholding obligations. The clearance certificate confirms that the withholding tax is not to be withheld from the transaction.

Generally a clearance certificate will need to be obtained by an Australian resident vendor to avoid tax being withheld by a purchaser. A non-resident vendor would not ordinarily be able to apply for a clearance certificate but is able to apply for a rate variation if it is believed a withholding of 12.5% is inappropriate and a lesser rate should apply. For example, a variation could be applied for if the non-resident vendor has Australian tax losses available to offset against the gain.

Where a withholding obligation exists, the purchaser must withhold the relevant amount at time of settlement and pay it to the ATO without delay. The penalty for failing to withhold is equal to the amount that was required to be withheld and paid. The ramifications for a purchaser failing to withhold are so severe they invariably will be almost forced to assume withholding applies unless the vendor can prove otherwise.

It is important to remember the new measures impose a non-final withholding tax which means a non-resident vendor is still obligated to lodge an Australian income tax return returning any gain, but they will be entitled to a tax credit (or even a tax refund) for the withheld amount.

CGT discount

The general 50% CGT discount rules do not apply where a foreign resident purchased an asset on or after 8 May 2012. Where an asset was purchased prior to that date the CGT discount may still apply to some of the capital gain. Essentially, this requires a calculation, valuation and apportionment to determine the market value increase prior and subsequent to the 8 May 2012. The portion of the increase prior to the 8 May 2012 will be subject to the 50% discount.

Main residence exemption

Currently, any individual, regardless of their tax residency status, who sells their home, can qualify for the CGT main residence exemption.

In the 2017 Federal Budget it was announced the main residence exemption will no longer apply to a vendor who is a non-resident for tax purposes at the time they sign a contract to sell their home, regardless of how long the home has actually been used as a main residence.

At the time of writing no Legislation has been introduced to reflect the change which will apply from 9 May 2017 and importantly, any homes held before that date are grandfathered until 30 June 2019.

Once (and if) these proposed changes do become law, it will be very important for vendors to determine their tax residency status before they sign a contract to sell a property that would potentially qualify for the full or partial main residence exemption.

It is important to note, there will be no apportionment of the time the individual used the home as a main residence – the only test is residency status at the time of signing the contract of sale.

This “all or nothing approach” can lead to catastrophic consequences for individuals that have used their properties as main residences for an extended period of time but contract to sell their properties when they are non-residents for tax purposes.

Conclusion

Non-residents should carefully consider their obligations on all transactions involving the disposal of taxable Australian property. As information on property sales is now readily available, we would expect the ATO will be vigilant in chasing non-resident taxpayers who do not lodge income tax returns disclosing CGT events where they have disposed of Australian property.